The Indebted States of America

The Manhattan Institute’s Steven Malanga is for my money the nation’s best expert on state and local finances, which in these days means mostly debt. His latest piece on the subject, in MI’s must-read City Journal, is here. Yes, Virginia (ok, maybe not Virginia but certainly Illinois and New Jersey) there is a debt crisis. It’s vastly more serious than state and local governments’ fraudulent numbers suggest. State courts have been complicit in the deception, and in the evisceration of constitutional limits on unsustainable obligations.

Steve’s chief proposed remedy is better disclosure of state and local finances, and I couldn’t agree more. (Any private actor who peddled debt the way muni debt is advertised and sold would be in jail.) Where, though, will the pressure come from—voters and taxpayers? Maybe. However, for many rational voter-taxpayers, the long-term fiscal health of the local jurisdiction is a matter of complete indifference. There’s always a majority for building bigger schools or larding up public employees’ future compensation (up to the point at which the voter’s own future benefits might be imperiled). I suspect that improved fiscal discipline will be driven mostly by people and institutions that can crush kneecaps—such as:

The Bond Markets. Today’s WSJ reports that “Detroit’s Woes Add to Angst Over Muni-Debt.” Yields have risen very sharply since April and now equal corporate bond yields—an amazing fact, considering that muni bonds are mostly tax exempt and, traditionally, less default-prone.

Bankruptcy Judges. Just yesterday, the thriving metropolis of San Bernadino, CA received bankruptcy protection. For some time now, the city has withheld pension payments owed to Calpers, the state pension fund. Calpers is not amused but will probably have to take a haircut, along with all other creditors. Same with Stockton, CA.

Receivers. In many states, delinquent municipalities can be taken over by appointed receivers. Detroit is, of course, the best-known and most spectacular example, but there are many other (including prosperous Nassau County, NY). Detroit emergency manager Kevyn Orr’s attempts to persuade everyone especially public sector unions, to take a haircut appear to have failed, and so they’re wrangling in court whether the city can or cannot obtain bankruptcy protection.

What all these mechanisms have in common is that to one extent or another, they divest voters and local politicians of control. There’s no other way.

(1) giving power back to local jurisdictions after a work-out or bankruptcy resolution is a lot like asking the Egyptian military to restore democracy: restore democracy to whom? Compared to the entrenched interests that ran these places into the ground in the first place, the Muslim Brotherhood may be a bargain.

(2) Let the pain become sufficiently widespread and acute, and the feds may intervene to provide “relief.” Steven Malanga’s splendid piece contains this nugget:

Earlier this year, a commission created by Chicago mayor Rahm Emanuel reported that that city’s health-care costs for retirees would rise from $109 million in the 2013 budget to $541 million in a decade. Chicago has since decided to drop its current health-insurance program and shift all retirees onto the health-insurance exchange being set up in Illinois under President Obama’s Affordable Care Act. That insurance will be cheaper because the federal government will subsidize the rates of the exchanges, basically getting taxpayers nationwide to pick up some of the cost for Chicago workers.

Told you so: Obamacare is one big bailout of state and local governments. Take my word for it: there’ll be plenty more of that sort of thing.

Michael S. Greve is a professor at George Mason University School of Law. From 2000 to August, 2012, Professor Greve was the John G. Searle Scholar at the American Enterprise Institute, where he remains a visiting scholar. His most recent book is The Upside-Down Constitution (Harvard University Press, 2012).

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I agree with respect to creditors having a far larger say. However, it always seems to come down to Judges deciding that pensioners have priority and that secured creditors can take a rather troublesome hike. Yes, they claim (in some cases) the State constitution requires that they so rule even when historic practice and, in some instances Federal law, dictates otherwise. Perhaps, it is best to simply let them fail!

Now for a pipedream! Would it not be interesting to see public sector union negotiating conducted not by politicians but rather by working / middle class voters who may have a rather different assessment of what their public servants are worth.

As I recall, there was a town in NY, perhaps, in the 80s that was put into receivership by a judge and a retired CEO was put in charge. As I recall, he had the town back in the black in about 1.5-2 years, simply by running it like a business.

Keep in mind that creditors likely had a better chance of vetting the risks when deciding to invest in municipal bonds for a city than the employees working generations as risks likely changed. Why should someone who took a financial risk, in the form of investing in bonds, be given a bailout when he/she was already paid a premium rate for taking such a risk?

Contrast that with an employee who, under a legally binding employment contract, has already provided services rendered. Some of those benefits come due at the end of the employment cycle so it seems easy for voters and politicians to put off paying for them. By all means provide voters with the true cost of locking people up for minute amounts of drugs, petty crimes, and the like; make like decisions on how aggressive a firefighting arm of a city might be, then let the people figure out what they are willing to pay for. Their cost of home insurance and the like may skyrocket, their personal safety may plummet, or the quality of their water may drop but they’ll have that small percentage of tax relief no matter what…

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